v2.4.0.8
Derivative and Hedging Activities (Note)
 6 Months Ended
Jun. 30, 2014
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative and Hedging Activities Disclosure [Text Block]
Derivative and Hedging Activities
Chesapeake uses commodity derivative instruments to secure attractive pricing and margins on expected production, to reduce its exposure to fluctuations in future commodity prices and to protect its expected operating cash flow against significant market movements or volatility. Chesapeake also uses derivative instruments to mitigate a portion of its exposure to interest rate and foreign currency exchange rate fluctuations. All of our derivative instruments are net settled based on the difference between the fixed-price payment and the floating-price payment, resulting in a net amount due to or from the counterparty.
Natural Gas and Oil Derivatives
As of June 30, 2014 and December 31, 2013, our natural gas and oil derivative instruments consisted of the following types of instruments:
•
Swaps: Chesapeake receives a fixed price and pays a floating market price to the counterparty for the hedged commodity.
•
Collars: These instruments contain a fixed floor price (put) and ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, Chesapeake receives the fixed price and pays the market price. If the market price is between the put and the call strike prices, no payments are due from either party. Three-way collars include an additional put option in exchange for a more favorable strike price on the call option. This eliminates the counterparty’s downside exposure below the second put option strike price.
•
Options: Chesapeake sells, and occasionally buys, call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess on sold call options, and Chesapeake receives such excess on bought call options. If the market price settles below the fixed price of the call option, no payment is due from either party.
•
Swaptions: Chesapeake sells call swaptions in exchange for a premium that allows a counterparty, on a specific date, to enter into a fixed-price swap for a certain period of time.
•
Basis Protection Swaps: These instruments are arrangements that guarantee a fixed price differential to NYMEX from a specified delivery point. Chesapeake receives the fixed price differential and pays the floating market price differential to the counterparty for the hedged commodity.
The estimated fair values of our natural gas and oil derivative instrument assets (liabilities) as of June 30, 2014 and December 31, 2013 are provided below. 
 
 
June 30, 2014
 
December 31, 2013
 
 
Volume    
 
Fair Value  
 
Volume    
 
Fair Value  
 
 
 
 
($ in millions)  
 
 
 
($ in millions)  
Natural gas (tbtu):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
293

 
$
(75
)
 
448

 
$
(23
)
Three-way collars
 
335

 
(27
)
 
288

 
(7
)
Collars
 
22

 
4

 
—

 
—

Call options
 
193

 
(195
)
 
193

 
(210
)
Call swaptions
 
—

 
—

 
12

 
—

Basis protection swaps
 
106

 
15

 
68

 
3

Total natural gas
 
949

 
(278
)
 
1,009

 
(237
)
Oil (mmbbl):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
18.3

 
(146
)
 
25.3

 
(50
)
Three-way collars
 
4.4

 
(12
)
 
—

 
—

Call options
 
38.9

 
(320
)
 
42.5

 
(265
)
Basis protection swaps
 
0.2

 
1

 
0.4

 
1

Total oil
 
61.8

 
(477
)
 
68.2

 
(314
)
Total estimated fair value
 
 
 
$
(755
)
 
 
 
$
(551
)

 We have terminated certain commodity derivative contracts that were previously designated as cash flow hedges for which the hedged production is still expected to occur. See further discussion below under Effect of Derivative Instruments - Accumulated Other Comprehensive Income (Loss).
Interest Rate Derivatives
As of June 30, 2014 and December 31, 2013, our interest rate derivative instruments consisted of swaps. We enter into fixed-to-floating interest rate swaps (we receive a fixed interest rate and pay a floating market rate) to mitigate our exposure to changes in the fair value of our senior notes. We enter into floating-to-fixed interest rate swaps (we receive a floating market rate and pay a fixed interest rate) to manage our interest rate exposure related to our bank credit facility borrowings.
The notional amount of our interest rate derivative liabilities as of June 30, 2014 and December 31, 2013 was $1.950 billion and $2.250 billion, respectively. The estimated fair value of our interest rate derivative liabilities as of June 30, 2014 and December 31, 2013 was $48 million and $98 million, respectively. 
We have terminated certain fair value hedges related to senior notes. Gains and losses related to these terminated hedges will be amortized as an adjustment to interest expense over the remaining term of the related senior notes. Over the next six years, we will recognize $10 million in net gains related to such transactions.
Foreign Currency Derivatives
We are party to cross currency swaps to mitigate our exposure to foreign currency exchange rate fluctuations that may result from the €344 million principal amount of our euro-denominated senior notes. The terms of the cross currency swaps were based on the dollar/euro exchange rate on the issuance date of $1.3325 to €1.00. Under the terms of the cross currency swaps we currently hold, on each semi-annual interest payment date, the counterparties pay us €11 million and we pay the counterparties $17 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay us €344 million and we will pay the counterparties $459 million. The swaps are designated as cash flow hedges and, because they are entirely effective in having eliminated any potential variability in our expected cash flows related to changes in foreign exchange rates, changes in their fair value do not impact earnings. The fair values of the cross currency swaps are recorded on the condensed consolidated balance sheet as an asset of $6 million as of June 30, 2014. The euro-denominated debt in long-term debt has been adjusted to $471 million as of June 30, 2014 using an exchange rate of $1.3692 to €1.00.
Effect of Derivative Instruments – Condensed Consolidated Balance Sheets
The following table presents the fair value and location of each classification of derivative instrument included in the condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013 on a gross basis and after same-counterparty netting: 
 
 
June 30, 2014
Balance Sheet Classification
 
Gross Fair Value
 
Amounts Netted
in Condensed Consolidated
Balance Sheet
 
Net Fair Value Presented
in Condensed Consolidated
Balance Sheet
 
 
($ in millions)
Commodity Contracts
 
 
 
 
 
 
Short-term derivative asset
 
$
56

 
$
(55
)
 
$
1

Long-term derivative asset
 
3

 
(3
)
 
—

Short-term derivative liability
 
(469
)
 
55

 
(414
)
Long-term derivative liability
 
(345
)
 
3

 
(342
)
Total commodity contracts
 
(755
)
 
—

 
(755
)
 
 
 
 
 
 
 
Interest Rate Contracts
 
 
 
 
 
 
Short-term derivative liability
 
(1
)
 
—

 
(1
)
Long-term derivative liability
 
(47
)
 
—

 
(47
)
Total interest rate contracts
 
(48
)
 
—

 
(48
)
 
 
 
 
 
 
 
Foreign Currency Contracts(a)
 
 
 
 
 
 
Long-term derivative asset
 
6

 
—

 
6

Total foreign currency contracts
 
6

 
—

 
6

 
 
 
 
 
 
 
Total Derivatives
 
$
(797
)
 
$
—

 
$
(797
)
 
 
December 31, 2013
Balance Sheet Classification
 
Gross Fair Value
 
Amounts Netted
in Condensed Consolidated
Balance Sheet
 
Net Fair Value Presented
in Condensed Consolidated
Balance Sheet
 
 
($ in millions)
Commodity Contracts
 
 
 
 
 
 
Short-term derivative asset
 
$
29

 
$
(29
)
 
$
—

Long-term derivative asset
 
11

 
(9
)
 
2

Short-term derivative liability
 
(231
)
 
29

 
(202
)
Long-term derivative liability
 
(362
)
 
9

 
(353
)
Total commodity contracts
 
(553
)
 
—

 
(553
)
 
 
 
 
 
 
 
Interest Rate Contracts
 
 
 
 
 
 
Short-term derivative liability
 
(6
)
 
—

 
(6
)
Long-term derivative liability
 
(92
)
 
—

 
(92
)
Total interest rate contracts
 
(98
)
 
—

 
(98
)
 
 
 
 
 
 
 
Foreign Currency Contracts(a)
 
 
 
 
 
 
Long-term derivative asset
 
2

 
—

 
2

Total foreign currency contracts
 
2

 
—

 
2

 
 
 
 
 
 
 
Total Derivatives
 
$
(649
)
 
$
—

 
$
(649
)
____________________________________________
(a)
Designated as cash flow hedging instruments.
As of June 30, 2014 and December 31, 2013, we did not have any cash collateral balances for these derivatives.
Effect of Derivative Instruments – Condensed Consolidated Statements of Operations
The components of natural gas, oil and NGL sales for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below. 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
($ in millions)
Natural gas, oil and NGL sales
 
$
1,917

 
$
1,869

 
$
4,065

 
$
3,464

Gains (losses) on undesignated natural gas, oil and NGL
derivatives
 
(210
)
 
535

 
(574
)
 
412

Gains (losses) on terminated cash flow hedges
 
(3
)
 
2

 
(20
)
 
(18
)
Total natural gas, oil and NGL sales
 
$
1,704

 
$
2,406

 
$
3,471

 
$
3,858



The components of interest expense for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below. 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
($ in millions)
Interest expense on senior notes
 
$
184

 
$
194

 
$
364

 
$
380

Interest expense on term loans
 
7

 
29

 
36

 
58

Amortization of loan discount, issuance costs and other
 
16

 
30

 
35

 
48

Interest expense on credit facilities
 
9

 
11

 
17

 
22

Gains on terminated fair value hedges
 
(1
)
 
(2
)
 
(2
)
 
(3
)
(Gains) losses on undesignated interest rate derivatives
 
(33
)
 
52

 
(51
)
 
57

Capitalized interest
 
(155
)
 
(210
)
 
(333
)
 
(438
)
Total interest expense
 
$
27

 
$
104

 
$
66

 
$
124


Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss)
A reconciliation of the changes in accumulated other comprehensive income (loss) in our condensed consolidated statements of stockholders’ equity related to our cash flow hedges is presented below. 
 
 
Three Months Ended
June 30,
 
 
2014
 
2013
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(247
)
 
$
(153
)
 
$
(287
)
 
$
(178
)
Net change in fair value
 
1

 
—

 
2

 
1

Gains (losses) reclassified to income
 
3

 
(1
)
 
(1
)
 
(1
)
Balance, end of period
 
$
(243
)
 
$
(154
)
 
$
(286
)
 
$
(178
)
 
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(269
)
 
$
(167
)
 
$
(304
)
 
$
(189
)
Net change in fair value
 
6

 
3

 
—

 
—

Losses reclassified to income
 
20

 
10

 
18

 
11

Balance, end of period
 
$
(243
)
 
$
(154
)
 
$
(286
)
 
$
(178
)

Approximately $150 million of the $154 million of accumulated other comprehensive loss as of June 30, 2014 represents the net deferred loss associated with commodity derivative contracts that were previously designated as cash flow hedges for which the hedged production is still expected to occur. These amounts will be recognized in earnings in the month in which the originally forecasted hedged production occurs. As of June 30, 2014, we expect to transfer approximately $25 million of net loss included in accumulated other comprehensive income to net income during the next 12 months. The remaining amounts will be transferred by December 31, 2022.

Credit Risk Considerations
Over-the-counter traded derivative instruments expose us to our counterparties’ credit risk. To mitigate this risk, we enter into derivative contracts only with counterparties that are rated investment-grade and deemed by management to be competent and competitive market makers, and we attempt to limit our exposure to non-performance by any single counterparty. As of June 30, 2014, our natural gas, oil and interest rate derivative instruments were spread among 17 counterparties.
Hedging Facility
Our secured commodity hedging facility with 18 counterparties provides approximately 1.063 bboe of hedging capacity for natural gas, oil and NGL price derivatives and 1.063 bboe for basis derivatives with an aggregate mark-to-market capacity of $17.0 billion. The facility is secured by proved reserves, the value of which must cover the fair value of the transactions outstanding under the facility by at least 1.65 times at semi-annual collateral redetermination dates and 1.30 times in between those dates, and guarantees by certain subsidiaries that also guarantee our corporate revolving bank credit facility, indentures, term loan and equipment master lease agreements. Chesapeake has significant flexibility with regard to releases and/or substitutions of pledged reserves, provided that certain requirements are met including maintaining specified collateral coverage ratios as well as maintaining credit ratings with either of the designated rating agencies at or above current levels. The counterparties’ obligations under the facility must be secured by cash or short-term U.S. treasury instruments to the extent that any mark-to-market amounts they owe to Chesapeake exceed defined thresholds. As of June 30, 2014, we had hedged under the facility 199 mmboe of our future production with price derivatives and 18 mmboe with basis derivatives.
Fair Value
The fair value of most of our derivatives is based on third-party pricing models which utilize inputs that are either readily available in the public market, such as natural gas and oil forward curves and discount rates, or can be corroborated from active markets or broker quotes. These values are compared to the values given by our counterparties for reasonableness. Since natural gas, oil, interest rate and cross currency swaps do not include optionality and therefore generally have no unobservable inputs, they are classified as Level 2. All other derivatives have some level of unobservable input, such as volatility curves, and are therefore classified as Level 3. Derivatives are also subject to the risk that either party to a contract will be unable to meet its obligations. We factor non-performance risk into the valuation of our derivatives using current published credit default swap rates. To date, this has not had a material impact on the values of our derivatives.
The following table provides information for financial assets (liabilities) measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013: 
As of June 30, 2014
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2) 
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Fair Value
 
 
 
 
($ in millions)
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
38

 
$
22

 
$
60

Commodity liabilities
 
—

 
(244
)
 
(572
)
 
(816
)
Interest rate liabilities
 
—

 
(48
)
 
—

 
(48
)
Foreign currency assets
 
—


6

 
—

 
6

Total derivatives
 
$
—

 
$
(248
)
 
$
(550
)
 
$
(798
)

As of December 31, 2013
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2) 
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Fair Value
 
 
 
 
($ in millions)
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
25

 
$
15

 
$
40

Commodity liabilities
 
—

 
(100
)
 
(493
)
 
(593
)
Interest rate liabilities
 
—

 
(98
)
 
—

 
(98
)
Foreign currency assets
 
—

 
2

 
—

 
2

Total derivatives
 
$
—

 
$
(171
)
 
$
(478
)
 
$
(649
)

A summary of the changes in the fair values of Chesapeake’s financial assets (liabilities) classified as Level 3 during the Current Period and the Prior Period is presented below. 
 
 
Derivatives
 
 
Commodity
 
Interest Rate
 
 
($ in millions)
Beginning Balance as of January 1, 2014
 
$
(478
)
 
$
—

Total gains (losses) (realized/unrealized):
 
 
 
 
Included in earnings(a)
 
(173
)
 
—

Total purchases, issuances, sales and settlements:
 
 
 
 
Settlements
 
105

 
—

Transfers(b)
 
(4
)
 
—

Ending Balance as of June 30, 2014
 
$
(550
)
 
$
—

 
 
 
 
 
Beginning Balance as of January 1, 2013
 
$
(1,016
)
 
$
—

Total gains (losses) (realized/unrealized):
 
 
 
 
Included in earnings(a)
 
362

 
(1
)
Total purchases, issuances, sales and settlements:
 
 
 
 
Sales
 
—

 
1

Settlements
 
60

 
—

Ending Balance as of June 30, 2013
 
$
(594
)
 
$
—

___________________________________________
(a)
 
Natural Gas, Oil and
NGL Sales
 
Interest Expense
 
 
 
2014
 
2013
 
2014
 
2013
 
 
($ in millions)
Total gains (losses) included in earnings for the
period
 
$
(173
)
 
$
362

 
$
—

 
$
(1
)
Change in unrealized gains (losses) related to
assets still held at reporting date
 
$
(133
)
 
$
353

 
$
—

 
$
—

(b)
The values related to basis swaps were transferred from Level 3 to Level 2 as a result of our ability to begin using data readily available in the public market to corroborate our estimated fair values.
Qualitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements
The significant unobservable inputs for Level 3 derivative contracts include unpublished forward prices of natural gas and oil, market volatility and credit risk of counterparties. Changes in these inputs impact the fair value measurement of our derivative contracts. For example, an increase (decrease) in the forward prices and volatility of natural gas and oil prices decreases (increases) the fair value of natural gas and oil derivatives and adverse changes to our counterparties’ creditworthiness decreases the fair value of our derivatives.
Quantitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements
Instrument
Type
 
Unobservable
Input
 
Range
 
Weighted
Average
 
Fair Value
June 30, 2014(a)
 
 
 
 
 
 
 
 
($ in millions)
Oil trades
 
Oil price volatility curves
 
9.12% - 18.73%
 
14.63%
 
$
(332
)
Natural gas trades
 
Natural gas price volatility
curves
 
19.54% - 38.70%
 
24.43%
 
$
(218
)
___________________________________________
(a)
Fair value is based on an estimate derived from option models.